Inside India

Can India become a global manufacturing hub?

One of the distinguishing features of India’s economy in recent decades is the relatively low contribution of its manufacturing sector to the country’s GDP, a figure hovering around 15% for most of that time. So while China and other emerging countries initially developed their economies by putting hundreds of millions of workers to manufacture cheap goods for export, India gravitated towards using its low cost resources to export services (for example and most famously, IT services).


This relative underperformance of the manufacturing sector needed to be corrected to address what is likely the biggest challenge of India’s economy, that is, to create enough jobs for a 900 million-strong young workforce. If India is successful in doing that, its “population dividend” will yield enormous benefits. If it fails, the weight of such large unemployed population could bring the country down to a crash. So, it is clear that relying on the services industries to do all the job-creation work is impossible, both from a demand and supply perspectives.


Hence the Indian government’s focus in incentivizing manufacturing growth. That effort, together with favorable macro trends, has yielded fruit in recent years, and more specifically, in the year 2023 that we just left behind. This past year, for example, India’s Purchasing Managers’ Index (PMI) has stayed consistently in the high 50s, signaling significant growth of manufacturing output in every single month of the year. Similarly, its Industrial Production Index ranks second amongst all G20 economies, only behind Turkey.


So what are the prospects for India’s manufacturing sector in 2024? Will the “China+1” approach that many industries are starting to take to their supply chains (that is, looking for at least one alternative production base to reduce risks of disruption) make India a prime destination for global manufacturing and thus lead to a boom in investment, job creation and output? Or will the factors that have traditionally dragged down India’s potential, together with the superior competitiveness of other emerging countries (hello Mexico, Indonesia and Turkey, to name a few), lead to a quick ceiling for India’s manufacturing?

Government incentives are not enough

One can assess a country’s potential as a global manufacturing base by looking at four main factors. First, the country’s government’s openness and incentive levels to attract foreign and local companies to set up factories in its territory. Second, the level of existing physical infrastructure to operate those factories and to transport goods in and out to any global location. Third, the availability and cost of workers with the required skills to employ in those factories. And finally, fourth, the existence of an industry ecosystem to support production (related non-primary services, components, required technology, etc). These four factors are developing at different speeds in India.


The one factor that is at full speed is the one related to government policy. Starting in 2020, the Indian government has been implementing the Production Linked Incentive (PLI) program, which offers subsidies to setting or expanding production in India in a few selected industries. As government incentives go, these have been successful. Take phone assembly, for example. In 2017, India was importing phones to the tune of $3.6 billion a year while exporting only $334 million. Today, and after PLI targeting this industry with special effort, India is only importing $1.6 billion worth of phones while exports have exploded to almost $11 billion (Source: Rajan and Lamba, 2023). Some import tariff moderation and administrative streamlining have also helped.


On the infrastructure front, things are also progressing nicely though the gap is still large. For instance, India keeps climbing the World Bank’s Logistics Performance Index ranking, placing 38th in 2022 from 54th in 2014, thanks to the investment that roads, ports and other infrastructure have received in recent years. That puts India at par with and even above other regions vying to become global manufacturing hubs like Turkey, ASEAN, Mexico or Eastern Europe.


In fact, this improvement in infrastructure have had a great influence in one of the most critical variables to attract manufacturing: Cost. For instance, a study by BCG shows that India’s landed cost (which includes all manufacturing costs, logistics and tariffs for a product made in the country) is 85 (on an indexed scale where 100 is the landed cost in the U.S.), which is quite similar to other attractive locations like Turkey, Mexico, Eastern Europe, etc (though worse than for example most South East Asian countries, which have indices around 80). So cost-wise, India seems to be ready. On the other hand, a trickier issue for India is the availability of labor with the adequate skills. The education system is clearly not able to churn out blue collar workers with the necessary level of training and that might be an impediment to attract and scale up manufacturing, especially of products that require quality and precision work. This is a problem that requires a longer-term solution, as changes in the educational system will not happen overnight.


Finally, India will require the building of industry ecosystems, with an adequate supply of services related to any specific manufacturing. The car industry might be a good example of that, as India has developed not only assembly manufacturing but also component, logistics, machinery design and production, administrative services, etc. This ecosystem factor is again one that takes time to develop, and it does so industry by industry, not across.

The trend in 2024?

In sum, it is likely that we will see Indian manufacturing continue to grow at a fast rate in 2024, as most macro trends and production incentives still act as a potent tailwind. But India’s manufacturing might cannot be built only on incentives. While PLI can act as a catalyst, attracting the necessary critical mass of investment to get things going in a particular industry, we can see that the other factors are just as critical and require time and probably more sophisticated efforts on the part of the government. And these other factors are still not really there.


Moreover, one must also consider the efforts of many other regions to become global hubs and their relative competitiveness. In that regard, India has advantages and disadvantages. For example, India is relatively far from the regions to which it should export (only China is a neighbor, and the relations are tense). A U.S. company looking for that “+1” would probably look at Mexico rather than India. And a European company would likely prefer building in Eastern Europe or Turkey before doing it in India. But on the plus side, none of those countries can also offer a gigantic and fast-growing internal market to sell to like India can. So when Apple looks at India, it does so not only as a production center with low landed costs but also as a fantastic revenue-generating opportunity. And that might make the difference in the end.